I know not everyone is aiming for early retirement, and that’s totally understandable. However, I have one suggestion that everyone should be working toward regardless of where you are in your financial life: an emergency fund.
The amount of your emergency fund may vary based on your life circumstances. Conventional budgeting suggests that you maintain 3 months income (or 3 months of your expenses) as your emergency fund in case of job loss. However, as an enlisted military family, it seems very unlikely that Eric would lose his job unexpectedly at no fault of his own, so we can reasonably expect to receive an income. However, there are some circumstances that are specific to military families, and some that are general to everyone, I think you should account for when determining the goal amount of your emergency fund.
- Depending on your duty station, save enough to fly home last minute. We live in Connecticut, and our families are in Chicago. Last summer, Eric’s mom passed away unexpectedly, and airfare was about $500/person round trip to go home. Our emergency fund was essential in this situation, and it was comforting to do what we needed to do instead of worrying about where the money would come from.
- Your emergency fund should include the full amount of your insurance deductibles. If you selected a $1000 deductible, but you don’t have $1000 on hand, you’re unprepared for any accidents or other claims.
- If you own a home, save enough to replace essential appliances on short notice. You may instead elect to have “sinking funds” in your budget (a category you contribute money to and let it accumulate until you need it) for these, as they shouldn’t be emergencies. You can reasonably assume the life expectancy of many appliances, but sometimes they do break as a surprise before they should, and you want to be prepared, especially if the item breaking is essential to eating or keeping your home warm.
- Although I expect Eric to keep his income, and I don’t consider this part of our emergency fund, I suggest living on last month’s income. This is one of the principles of YNAB in which your current month’s income funds next month’s expenses. (All of our income in March will pay our bills in April.) The positive to this in a military sense is that if there ever is a true government shutdown and paychecks aren’t deposited, we are fine for the current month. This came in handy when my short-term disability was processed incorrectly and my paycheck was delayed a month.
- If there is secondary income and it is essential to your budget and there’s nothing you can cut to live on one income, I would save 3 months worth of the second income as part of the emergency fund, or at least 3 months of the essential spending with it. A good example would be if you pay for childcare because you both work; if one of you loses a job but is looking for a new one, you can’t reasonably just cut out childcare, but you may not be able to support it on one income. In this case, I would save 3x your childcare expenses in case the job hunt takes longer than expected.
- If you have a home in another duty station that you rent out to tenants, you would want to save enough to replace essential appliances there, as well as 3 months of mortgage expenses there. Being a landlord can be very unexpectedly expensive, and you can’t leave your tenant in a cold house when their furnace breaks. If your tenant moves and you have a vacant property, you still need to be able to pay the mortgage. I would not keep this as a part of your emergency fund, but as a part of a separate account specific to that property, and it should be something you save up for before you decide to rent out a property.
For a real world example, for our budget this would mean:
$1500 in emergency travel
$500 in deductible totals
$5000 for emergency heat pump or refrigerator replacement (we’re buying a house!)
$3700 in “last month’s income”
$1800 in childcare for 3 months
$12500 total
I know that seems insane. However, that is specific to our situation. If you don’t own a home, your total would be lower. If you are a SAHM, your expenses may be lower and you don’t have childcare. However, if you have 3 kids or live overseas, your emergency travel amount may be significantly higher. A perspective to consider while you’re planning your emergency fund is that it isn’t money you’re spending right now. You’re planning for your peace of mind. But this money has a purpose, and it is to cover emergencies.
Things that are not emergencies:
- An invitation to dinner with a friend two days before payday
- A vacation to Disney to surprise your four-year-old
- A sale at Michael Kors (if Louis Vuitton ever had a sale, I might consider that an emergency. Kidding!)
- Someone selling a motorcycle, car, boat, truck, ATV, or anything else you think is really cool
- A kitchen renovation
- Bills you could have reasonably expected and didn’t prepare for
I could go on… You’re probably like, “duh, I know a Michael Kors sale isn’t an emergency,” but I think there is a psychological effect of seeing large amounts of money in your bank account that can lead to making off-the-cuff decisions like that. Don’t borrow from your emergency fund to buy things that aren’t an emergency, because if an emergency comes up, you may be unprepared.
But how do I even start saving that much money?
Start small. For the first few years of our marriage, our emergency fund was $1000, even though that wouldn’t be enough to buy one last-minute plane ticket home from Hawaii. It was enough to fix the car by surprise before our Vehicle Maintenance fund was filled enough. Set up a savings account with no other purpose (or even a certificate that allows additional deposits), and set up automatic transfers. Even $25 per paycheck would save $600 a year.
Don’t focus on how much more you have to save; focus on what you can cover with what you have saved. If you’ve never saved an emergency fund before, think about how stressful it was to obtain funds in a pinch. Did you have to apply for a loan and cross your fingers that the loan officer was generous that day? Did you have to call family and ask for help? Having an emergency fund can prevent that stress, and you can set goals based on how much further you are. You can break up your fund into the things it’s designed to cover, and save for those goals one at a time.
What if I have to spend some of it?
So you’re $2000 into saving for your $6000 goal, and you rear-end someone. Your deductible is $500, so you pay your $500 share of repairs, and keep going to replenish your emergency fund. Even if the $2000 you saved was earmarked for “emergency travel,” you can use it for other emergencies and keep going toward your goal.
If your emergency fund is fully funded (you’ve saved $6000 of your $6000 goal), and you suddenly have to fly home, you can spend the $1500 for plane tickets and have peace-of-mind in reaching your destination. Once you’ve filled your emergency fund, you may have moved on to other savings goals, so you can redirect your savings back into filling your emergency fund.
What do I do with it when there’s not an emergency?
When you’ve got your whole emergency fund saved, or even a big chunk of it, you’re probably thinking, “great, now I have $10,000 earning 0.25% interest in a savings account… I could be doing better things with this!” You’re probably right. There are definitely ways to earn more on your money than in a savings account, but I don’t recommend subjecting your emergency fund to any risk. With an emergency fund, I would keep it in short-term CDs (some allow for additional deposits, so you could build your emergency fund while it is in a CD), and any other high interest accounts you have access to. Some credit unions offer 3% checking accounts, but they have caveats like direct deposit or web bill pay, and you don’t want this to be your everyday use money, so that might not work for your family. If you do have it in a CD and have an interest penalty because you need to use it, the interest it’s okay. If you had it in the stock market and lost value, you would be out of luck when you need to access the funds, because emergencies don’t wait for stock markets to recover. So, as much as it hurts to hear, find a “good” savings account, a CD, or a high-interest checking account, and leave the money there until it is truly a necessity.
I know it is daunting, but it is so worth it. Many years ago, I used to ask everyone I know, “If you could have anything in the world, no matter what it cost, what would it be?” Eric gave me the best answer I could ever imagine: “Peace of mind.” And as ridiculous as it is, this is the first step in financial peace of mind. Big emergencies become bumps in the road because we planned for them, and it builds the foundation for further financial success.
